Appeal of Composite CAMELS Rating - (First Quarter 1998)

Background

A formal appeal was received concerning a bank's composite CAMELS rating of "5." The composite rating is based on capital, asset quality, management, earnings, liquidity, and sensitivity to market risk (CAMELS).

Composite CAMELS Rating of "5"

In the appeal letter, management explains that the current examination was conducted six months after the previous report of examination (ROE) had been issued, when the bank's composite CAMELS rating was downgraded to a "5." Management and the board of directors did not disagree with the previous examination conclusions; however, they believe their accomplishments since that examination are impressive and that the condition of the bank has greatly improved. In the appeal letter, management stated that the board perceives that regardless of the bank's accomplishments and improved condition, there was no intention by the supervisory office to fairly consider upgrading the bank's rating. In an effort to support the "5" rating, management believes the supervisory office viewed every "recommendation" as a severe problem. Management gives the following factors as their basis for appealing the "5" rating:

The bank returned to profitability while the examiners were still conducting their on-site examination. Capital levels were not a threat to the bank's solvency. Alternative sources of capital have continually provided capital augmentation as needed. Vintage data and delinquency trends prove the condition of the portfolio has improved as anticipated. Management and the board have taken quick and decisive action to control the risks in the portfolio. Operational issues at the bank's affiliate have been resolved.

Compliance systems at both the bank and the affiliate have greatly improved resulting in a satisfactory rating. The board and management have made good faith efforts to comply with the enforcement action.

Based on the aforementioned facts, the board believes that the bank is neither a threat to the insurance fund nor is failure of the bank highly probable.

The ROE provides the following verbiage to support the composite CAMELS "5" rating:

The bank's condition remains weak and financial performance is unstable. Management and board supervision do not provide for effective management and control of risks within the bank. The credit card product, offered as the primary source of revenue, has not been adequately evaluated. Large capital injections were needed during 1996 to provide for continued operations.

Despite better staffing levels, increased control over the bank's affiliate, and improved loan supervision, the credit card portfolio still generates excessive delinquencies and loan losses. To reduce risk, your management team must develop credit risk controls targeted at underwriting, to supplement the improved collection strategies. You must still address serious weaknesses in planning, risk management, and management information systems.

Discussion

Composite CAMELS Rating of "5"

Composite ratings are based on a careful evaluation of an institution's managerial, operational, financial, and compliance performance. The six key components used to assess an institution's financial condition and operations are: capital, asset quality, management, earnings, liquidity, and sensitivity to market risk (CAMELS). Composite 4 and composite 5 ratings are each defined below:

Composite 4-financial institutions in this group generally exhibit unsafe and unsound practices or conditions. There are serious financial or managerial deficiencies that result in unsatisfactory performance. The problems range from severe to critically deficient. The weaknesses and problems are not being satisfactorily addressed or resolved by the board of directors and management. Financial institutions in this group generally are not capable of withstanding business fluctuations. There may be significant noncompliance with laws and regulations. Risk management practices are generally unacceptable relative to the institution's size, complexity, and risk profile. Close supervisory attention is required, which means, in most cases, formal enforcement action is necessary to address the problems. Institutions in this group pose a risk to the deposit insurance fund. Failure is a distinct possibility if the problems and weaknesses are not satisfactorily addressed and resolved.

Composite 5-Financial institutions in this group exhibit extremely unsafe and unsound practices or conditions; exhibit a critically deficient performance; often contain inadequate risk management practices relative to the institution's size, complexity, and risk profile; and are of the greatest supervisory concern. The volume and severity of problems are beyond management's ability or willingness to control or correct. Immediate outside financial or other assistance is needed in order for the financial institution to be viable. Ongoing supervisory attention is necessary. Institutions in this group pose a significant risk to the deposit insurance fund and failure is highly probable. [OCC Bulletin 97-1, January 7, 1997.]

Conclusion

Composite CAMELS Rating of "5"

While the condition of the bank remained serious as of the examination date, it was concluded a composite CAMELS rating of "4" better reflects the condition of the bank at that time, rather than the "5" rating that was assigned. Consistent with the ROE, the supervisory office appropriately evaluated and rated the bank's asset quality, management, earnings, liquidity, and sensitivity to market risk as of the examination date. However, for the reasons stated below, the bank's capital position as of the examination date justified a rating of "4" and supported an upgrading of the overall CAMELS rating to a "4" as well.

OCC Bulletin 97-1 specifies that a financial institution is expected to maintain capital commensurate with the nature and extent of risk to the institution and the ability of management to identify, measure, monitor, and control these risks. A rating of "4" indicates a deficient level of capital. In light of the institution's risk profile, viability of the institution may be threatened, and assistance from shareholders or other external sources of financial support may be required. A rating of "5" indicates a critically deficient level of capital such that the institution's viability is threatened and immediate assistance from shareholders or other external sources of financial support is required. While the bank's capital level was definitely deficient and below the requirements of the enforcement action, capital injections made prior to the examination put the bank's leverage ratio at 4.21 percent as of the examination date. Accordingly, the capital component rating was changed to a "4."